Firm thinks the recent sell-off of VECO is overblown and continues to recommends the stock as their top pick. Although investors are worried about the MOCVD equipment cycle getting too hot and heavy, JPM remains unconcerned about weakness in LED industry fundamentals. They also believe weakness in the stock will be short-lived as they expect news flow over the next few months to be positive for LED demand and drive upside revisions unit demand for LED backlighting and general lighting applications. They are hosting a conference call on Monday morning at 10:30AM EST with the CEO of Veeco, John Peeler.

The current LED cycle is only at the top of the 3rd inning, in JPM view, and concerns about the cycle reaching its peak are overblown. This is not the same old 2 quarter up, 2 quarter down semi equipment cycle of the past decade. They think the current LED demand cycle is analogous to the semi cycle in the early 1990s when a very large new end demand driver, the desktop PC, drove significant growth in demand for the devices that enabled that product. They think the current penetration trajectory of LEDs for large area LCD backlighting will result in a long-duration multi-year capital spending cycle similar to what happened 20 years ago for semi device makers.

It’s a duopoly, and MOCVD equipment makers get deposits, which is not the case for most semi equipment makers. Although this does not prevent excessive ordering of equipment, JPM thinks it reduces the risk of this activity occurring. Instead of being concerned about share between Veeco and Aixtron they think investors should view the MOCVD market as a duopoly, where neither player is willing to lower price in order to gain share. Firm thinks this is a more favorable scenario than exists in most other tech hardware sectors, where a large number of competitors are continually undercutting each other in order to gain share.

Wafer size increases do not increase the amount of wafer surface area processed, which is a different trend vs. what has occurred in the semi industry as MOCVD batch reactors are very complex in nature and chamber sizes are slow to evolve. Although LED makers expect higher yield and performance levels when moving to large wafer sizes, they do not doubly benefit from more surface area processed at a given time due to the larger wafer. This slows the productivity improvement vs. what investors might expect when comparing the LED industry to the semi industry. JPM thinks this will result in a longer capex cycle than most expect.

Don’t compare subsidies in China for LED equipment to solar subsidies as China’s LED equipment subsidy is not driving end demand. The subsidy in China is not what is causing MOCVD equipment to be purchased. Real end demand strength in LCD backlighting and general lighting is driving the significant industry manufacturing capacity expansion. The subsidy is likely shifting the competitive landscape in favor of Chinese companies, but they do not think emerging LED makers in that country are building out capacity speculatively but in response to the need for more supply.

Veeco is not the same company that veteran tech investors remember as the company is operating at a higher execution level and JPM expects it to generate a significant amount of FCF for the foreseeable future. Veeco has cut costs in its legacy equipment product lines, Data Storage, and Metrology, and it is more outsourced than most semi-equipment makers. This reduces the need for building internal infrastructure, allows the company to better weather capex cycles, and in JPM view makes it a better investment than many go-to tech hardware names.

Remain OW and recommend investors increase their long positions on the recent weakness, which they believe is being caused by short-term investors taking profits. VECO currently trades at about 8x JPM C11E PF EPS vs. alternative energy group average of 19x.

Notablecalls: With the name down 10pts from it's recent $54/sh high (in just 4 days), we may see a bounce in the name.

Note that competitor Aixtron (AIXG) is already trading up ~5% overseas, following similar sell-off last week.

What I like from the trading perspective is the fact J.P. Morgan is hosting a 10:30 AM ET conf call w/ the CEO. He is going to do his best to push the stock back on track, thus providing support for the bounce.

The bears believe the outlook for 2011 becomes more risky as it remains uncertain if the current TV backlighting-related demand cycle will seamlessly transition into the general lighting cycle. In addition, the market entry of US heavyweight Applied Materials, which already announced that it customers at its analyst day on 30 March, could increasingly be seen as a risk factor. JPM comments & the upcoming conf call should alleviate some of these fears.

I'm thinking the stock can trade towards $46, with $47 level not out of question if the conf call goes well & the general market plays ball.

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